Why Private Buyers Are Dominating the Net-Lease Market

By Randy Blankstein, President, The Boulder Group

Cap rates in the fourth quarter of 2014 for the single-tenant, net leased retail sector remained unchanged at their historic low cap rate of 6.50 percent for the third consecutive quarter. Additionally, cap rates for the net-lease office sector compressed by nine basis points to a new historic low cap rate of 7.31 percent. Net-lease industrial cap rates rose slightly to 8.03 percent during this period. Limited movement in interest rates and a restricted development pipeline are contributing factors to the stagnant cap rates in the retail sector. Stable capital markets have caused investors to hold firm at pricing for retail assets in order to achieve desired returns. However, long-term leases in core markets continue to demand an additional premium.

In 2014, a notable change occurred in the buyer type for the retail net lease market. In 2014, private investors accounted for 60 percent of net-lease retail transactions, a significant increase when compared to 42 percent in 2013. Private buyers continue to dominate the net lease market in the low cap rate environment as institutions cannot typically pay the cap rate premiums due to yield restrictions. The majority of investors acquiring low cap rate properties, including 1031 exchange investors, are seeking new construction assets with investment grade tenants. For example newly constructed Walgreens, McDonald’s ground leases and 7-Eleven properties experienced cap rate compression of 5, 25 and 13 basis points respectively in the fourth quarter.

The net lease market is expected to remain active in 2015 as investor demand for this asset class continues, however the expectation is that there will be limited movement in valuations moving forward. In a recent national survey conducted by The Boulder Group, the majority of active net- lease participants expect cap rates to remain unchanged or rise in 2015. The largest segment of net-lease participants expect cap rates to rise slightly from 2014 levels by the end of 2015.